IT'S A Summertime Carnival Ride

DKW, June 20, 2011

First it's up. Then it's down and around and upside down, up and down again. No, I am not talking about the rollercoaster ride at the summer carnival. But it is the same feeling I am getting from the economic tracks lately.

The economic recovery subsequent to the end of the Great Recession is two years old this month. Real GDP growth was up 2.9% in 2010. Personal income was up 3.1% and corporate profits surged 29.2%. Industrial production indicators were running full blast. The ISM manufacturing and nonmanufacturing indices were at or above 60 during Q1 2011. The economy was adding over 200,000 jobs per month in Q1.

Still, there is a general lack of excitement along the midway. It has been a torpid recovery across many measures. For example, it usually takes one or two quarters, once three, to truly recover economic output levels from the recession trough. This time around it took six quarters from the trough in June of 2009 for GDP to exceed prerecession levels. Likewise on the consumption term (GDP = C + I + G + (M-X)). Only equipment and computer software investments have reached new highs, with nonresidential structures barely even with prerecession levels. Residential construction expenditures are still in the doldrums at $334 billion compared to $536 billion in Q4 2007 and $813 billion in Q1 of 2006.

The equipment and software investments are labor saving investments. Structure investments indicate expansion. Taken together, that is the main reason employment growth has been less than desired. Only now are we getting real economic expansion, and that has to overcome the productivity increases before we put significant numbers of people back to work, much less hire on new people.

Job growth had been promising in the last few months, adding better than 200,000 jobs per month in the first quarter of 2011, even with net negative public sector changes. Wisconsin has added a net positive 25,000 private sector jobs year to date. However, the May jobs numbers took some of the thrill out of the loop-d-loop, increasing by only 54,000 at the national level. Wisconsin added only 900 in May. The headline May U3 unemployment rate in the U.S. crept up to 9.0%. The more encompassing U6 rate is more like 15%. Wisconsin's May U3 came in up a tick at 7.4%. The good news is that the workforce and employment continue to grow.

After showing impressive numbers in the first quarter of 2011, most manufacturing and production indexes are well off their peaks. The national ISM manufacturing index, at 60.4 in April, fell back to 53.5 in May. (Greater than 50 designates expansion.) The Chicago region figure dropped to 56.6 in May from a lofty 67.6 April.

Housing prices and sales are stagnant at best and still falling in many locales. April housing starts continue a two-year flat line below 600,000 units SAAR, half what they were three years ago and a quarter of what they were at the peak. Construction spending is down year-over-year for four straight years. The construction industry has a national unemployment rate of 16.3%. The general national housing recovery is yet at least a year out with a continued overhang of underwater and foreclosed properties still shadowing the advertised inventory. Wisconsin is in the middle of the pack in the percentage of homeowners with negative mortgage equity at just under 20%. Nevada leads with upwards of 65%, followed by Arizona, Florida, Michigan, Georgia and California. There are pockets of housing stability beginning to blossom in desirable locations, such as Wisconsin, but rapid price escalation is hardly expected.

Fallout from the property market collapse still has many banks facing insolvency, mainly due to underperforming housing and commercial real estate portfolios. Wisconsin financial institutions as a whole are showing losses for the seventh quarter in a row, and nine of the last eleven. Moreover, several European countries and even the U.S. are facing default, although it is more a function of politics here in the states.

The winding down of ARRA money and QE2 are pulling money and activity out of the economy in both the public and private sectors. Federal, state, and local budget challenges will plague the public sector for years to come. Wisconsin state government April employment has declined 5,400 jobs year over year. With the state's biennial structural deficit projected at about $3.5 billion, Wisconsin government employment should fall further over the short-term.

The big change that occurred through this business cycle is that we suddenly moved from an economy based on rapid wealth accumulation (stock and home equity) where we spent every dollar we earned and then some, to one based on stagnant cash flow (earnings) where consumption, debt payments, and savings must now be paid from take-home pay.

So when is the next Up?

The stomach settling flat track, of which there is little on a coaster or in the current economy, is that the emerging economies are still growing nicely. This past economic tumble has been pretty much confined to the western developed countries. China, India, Brazil have continued economic growth at paces that have called for fiscal and monetary braking. U.S. and Wisconsin exports are climbing. The export markets have supported the manufacturing sector. While off lofty highs, manufacturing indicators are still expansionary. Low U.S. interest rates should keep the U.S. dollar relatively weak, enticing demand for U.S. products. Ten-year Treasuries rates went under 3.0%.

On the whole, the U.S. economy will post significant growth when consumer spending picks up. That will happen when: 1) consumers, banks, and businesses finish deleveraging (paying down debt), 2) real income increases markedly (requiring increased employment), and 3) banks and businesses are willing and able to lend and borrow money.

In the meantime, don't eat too much cotton candy.

Written by Dennis Winters, Chief Economist and OEA Administrator. June, 2011.